Magni, Carlo Alberto (2007): CAPM and capital budgeting: present versus future, equilibrium versus disequilibrium, decision versus valuation.
This is the latest version of this item.
Download (239kB) | Preview
This paper deals with the use of the CAPM for investment decisions and evaluations. Four different measures are deductively drawn from this model: the disequilibrium Net Present Value, the equilibrium Net Present Value, the disequilibrium Net Future Value, the equilibrium Net Future Value. It is shown that all of them may be used for accept-reject decisions, but only the equilibrium Net Present Value and the disequilibrium Net Future Value may be used for valuation, given that they enjoy the additivity property. The two nonadditive indexes cannot be deducted from the CAPM assumptions if the decision problem “invest/no invest” is reframed as “invest in Z/invest in Y”. Despite their additivity, the equilibrium Net Present Value and the disequilibrium Net Future Value are unreliable for both valuation and decision, because they do not signal arbitrage opportunities whenever there is some state of nature for which they are decreasing functions with respect to the end-of-period cash flow. In this case, the equilibrium value of a project is not the price it would have if it were traded in the security market. This result is the capital-budgeting counterpart of Dybvig and Ingersoll’s (1982) result.
|Item Type:||MPRA Paper|
|Institution:||Dipartimento di Economia politica, University di Modena e Reggio Emilia, Italy|
|Original Title:||CAPM and capital budgeting: present versus future, equilibrium versus disequilibrium, decision versus valuation|
|Keywords:||Capital budgeting; investment appraisal; project; risk-adjusted rate of return; CAPM; equilibrium; disequilibrium; present value; future value; decision; valuation; cost; risk.|
|Subjects:||G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions
D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
G - Financial Economics > G3 - Corporate Finance and Governance > G31 - Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
G - Financial Economics > G3 - Corporate Finance and Governance
B - History of Economic Thought, Methodology, and Heterodox Approaches > B4 - Economic Methodology > B41 - Economic Methodology
|Depositing User:||Carlo Alberto Magni|
|Date Deposited:||18. Jun 2009 02:05|
|Last Modified:||13. Feb 2013 05:34|
Ang, J. S., and Lewellen, W. G. (1982). Risk adjustment in capital investment project evaluations, Financial Management, 11(2), 5–14, Summer.
Bierman, H. and Hass, J. E. (1973). Capital budgeting under uncertainty: a reformulation. Journal of Finance, 28(1), 119–129. Bierman, H. and Hass, J. E. (1974). Reply, Journal of Finance, 29(5), 1585.
Bogue, M. C. and Roll, R. (1974). Capital budgeting of risky projects with ‘imperfect markets’ for physical capital, Journal of Finance, 29(2), 601–613, May.
Bossaerts P. L. and Ødegaard, B. A. (2001). Lecture on Corporate Finance. Singapore: World Scientific Publishing. Copeland, T. E. and Weston, J. F. (1983). Solutions Manual for Financial Theory and Corporate Policy - second edition. Addison-Wesley Publishing Company.
Copeland, T. E. and Weston, J. F. (1988). Financial Theory and Corporate Finance. Addison- Wesley Publishing Company.
Dybvig P. H. and Ingersoll J. E. (1982). Mean-variance theory in complete markets, Journal of Business, 55(2), 233-251.
Ekern, S. (2006). A dozen consistent CAPM-related valuation models – so why use the incorrect one?. Department of Finance and Management Science, Norwegian School of Economics and Business Administration (NHH). Bergen, Norway. Available online at http://www.nhh.no/for/dp/2006/0606.pdf.
Grinblatt, M. and Titman, S. (1998). Financial Markets and Corporate Strategy. Irwin/McGraw- Hill.
Hamada, R. S. (1969). Portfolio analysis, market equilibrium and corporation finance, Journal of Finance, 24(1), 13–31, March.
Jones, R. G., Jr. and Dudley D. (1978). Essential of Finance. Englewood Cliffs, N. J.: Prentice- Hall.
Lewellen, W. G. (1977). Some observations on risk-adjusted discount rates. Journal of Finance, 32(4), 1331–1337, September.
Litzenberger, R. H. and Budd, A. P. (1970). Corporate investment criteria and the valuation of risk assets, Journal of Financial and Quantitative Analysis, 5(4), 395–418, December.
Magni, C. A. (2007a). Project selection and equivalent CAPM-based investment criteria, Applied Financial Economics Letters, 3(3), 165−168, May .
Magni, C. A. (2007b). Project valuation and investment decisions: CAPM versus arbitrage, Applied Financial Economics Letters, 3(2), 137–140, March.
Mason, S. P. and Merton, R. C. (1985). The Role of Contingent Claims Analysis in Corporate Finance, in E. Altnnan and M. Subrahymanyam (Eds.), Recent Advances in Corporate Finance, Irwin, Boston, MA.
Mossin, J. (1969). Security pricing and investment criteria in competitive markets, American Economic Review, 59(5), 749–756, December.
O’Hanlon J. and Peasnell, K. V. (2002). Residual income and value creation: the `missing link', Review of Accounting Studies, 7(2/3), 229−245.
Promislow, S. D. (2006). Fundamentals of Actuarial Mathematics. Chichester, UK: John Wiley & Sons.
Rendleman, R. J. (1978). Ranking errors in CAPM capital budgeting applications, Financial Management, 7(4), 40–44, Winter.
Rubinstein, M. (1973). A mean-variance synthesis of corporate financial theory, Journal of Finance, 28, 167–182, March.
Senbet, L. W. and Thompson, H. E. (1978). The equivalence of alternative mean-variance capital budgeting models, Journal of Finance, 33(2), 395–401, May.
Smith, J. E. and Nau, R. F. (1995). Valuing risky projects: option pricing theory and decision analysis. Management Science, 41(5), 795–816
Stapleton, R. C. (1971). Portfolio analysis, stock valuation and capital budgeting decision rule for risky projects, Journal of Finance, 26(1), 95–117, March.
Stapleton, R. C. (1974). Capital Budgeting under Uncertainty: A Reformation: Comment, Journal of Finance, 29(5), 1583–1584.
Tuttle, D. L. and Litzenberger, R. H. (1968). Leverage, diversification and capital market effects on a risk- adjusted capital budgeting framework, Journal of Finance, 23(3), 427–443.
Ukhov, A. D. (2006). Expanding the frontier one asset at a time. Finance Research Letters, 3, 194–206.
Weston, J. F. and Chen, N. (1980). A note on capital budgeting and the three Rs, Financial Managemen, 9(1), 12–13, May.
Weston, J. F. and Copeland, T. E. (1988). Managerial Finance. London, UK: Cassell Educational Limited, 2nd Britith edition.
Young, S. D. and O’Byrne, S. F. (2001). EVA and Value-Based Management. McGraw-Hill.
Available Versions of this Item
CAPM and capital budgeting: present versus future, equilibrium versus disequilibrium, decision versus valuation. (deposited 29. Oct 2007)
- CAPM and capital budgeting: present versus future, equilibrium versus disequilibrium, decision versus valuation. (deposited 18. Jun 2009 02:05) [Currently Displayed]